Emergency fund vs. Sinking Fund: What’s the Real Difference?

Emergency fund vs. Sinking Fund: What’s the Real Difference?

Knowing when and how to use your various financial accounts best can be hugely beneficial for protecting your financial assets as well as your peace of mind.

While life can throw us some expensive curveballs, the peace of mind that comes from having extra funds set aside for them is priceless.

This article will go over two such methods for saving and helping those accounts grow: sinking funds and emergency funds.

Emergency vs. Sinking: Let’s Explore

The average credit card annual percentage rate currently sits at around 16%. Some cards climb even higher, with rates at 25%. By utilizing a savings fund for any major expenses, you can bypass the extra money you may end up paying by using a credit card.

For example, say you’ve got a $2,000.00 unexpected car repair bill to pay. If you’re using your 25% interest rate card to take care of it, you could end up paying over $700 worth of interest during a 12-month period. Unexpected expenses can be stressful and adding that interest on top of your expense only exacerbates the stress.

This type of unexpected expense would fall into an emergency fund bucket.

Emergency Fund

What exactly is an emergency fund? It’s a reserve of cash you put aside for any major unplanned financial expenses such as large car repairs, medical bills, or loss of a job. Anything typically outside of your regular expenses.

The amount you put into an emergency fund is entirely dependant upon your income and day-to-day expenses. However, creating a habit of socking away even a little bit each paycheck can help.

It’s generally a good rule of thumb to have at minimum 3 months worth of expenses saved up. That way, when life throws you a financial curveball, you’ll be prepared to handle it.

Sinking Fund

While emergency funds exist for unexpected expenses, sinking funds exist for expected expenses. It is an intentional fund for things like vacations, planning a wedding, or charity donations. 

Some people set up separate accounts for each planned expense; that way, the expenses are kept separate, and you’re more likely to stick to your plan and curb impulse spending.

You can look back at your bank account for annual subscriptions, registrations, and general spending habits to see which categories you may want to set up separate funds for. Things like birthdays, holidays, car registration expenses, and the like are all common items you can plan for.

The Cost of Saving Money

When it comes to starting up your own emergency or sinking fund accounts, it is best to take a look at your income and general spending habits as a whole before diving into the building either.

Remember to look at your old bank statements and estimate how much you’d like to save to feel comfortable with any unplanned expenses. Once you have a general grasp, you can begin to contribute regularly and watch your savings grow.

If you’re interested in learning more about various financial services, please check out our Finance section here.

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